The Only Way Out Of The Great Stagnation

We have misunderstood our situation. We are not as well off as we thought we were.

Joseph Stiglitz

There are only three outcomes of the ongoing Economic Stagnation, according to the Richard Duncan, author of the interesting new book, The New Depression: either total collapse (if we abruptly cut government spending) or endless stagnation (if we muddle along like Japan) or massive new borrowing and investment to grow our way out. According to Duncan, those are the only choices.

How can we safely deleverage?

Duncan explained on CNBC’s Squawkbox on Monday that the global economy has been living on credit. Credit grew from $1 trillion in 1968 to $50 trillion in 2008. The growth in credit fueled economic growth and created a massive world-wide economic boom. The problem is that that can’t go on like this any more because the private sector can’t bear any more debt. The boom funded by $50 trillion of debt now risks turning into a very severe protracted economic depression.

Duncan is not alone is his concern about the current period of very slow economic growth called variously, the Great Stagnation, The Great Recession or the Lesser Depression. Mohamed El-Erian and and colleagues at the investment management firm Pimco developed the concept of the "new normal" i.e. the idea that coming out of the financial crisis, the economy would not recover in a normal cyclical fashion. They wrote in May 2009: "growth will be subdued for a while and unemployment high; a heavy hand of government will be evident in several sectors.”

Initially, the concept of the new normal was controversial. Many rushed to dismiss it as overly pessimistic for ignoring historically robust drivers of cyclical rebounds. Solid analytical backing for "the new normal" framework followed in work by economists Carmen Reinhart, Ken Rogoff and Mike Spence. The history of the last three years has also tended to confirm the hypothesis.

The challenge now is to find a way to “safely deleverage" and overcome the many years during which policymakers lost sight of sustainable drivers of growth and jobs and instead ended up relying on excessive leverage, over-indebtedness and credit entitlement.

According to Duncan, the only reason we are not already in an actual depression is that the global economy is on life support, i.e. trillion dollar budget deficits. That’s what is enabling debt to go on slightly expanding rather than contracting. Without these trillion dollar deficits, we would immediately spiral into a great depression.

Duncan sees only three paths forward for us as a society

Abruptly cut budgets and spiral into depression: Every economy is made up of just four parts. The components are personal consumption about 70 percent of GDP in the US; Business investment, about 16 percent of GDP in the US; Government spending 20 percent of GDP in the US; and net trade which deducts 4 percent of GDP for the US. If we do what the drastic budget cutters want, we would cut the budget deficit by $1.3 trillion. But if the government spends $1.3 trillion less, then millions of people lose their jobs and many firms go out of business. Consumption collapses and business investment collapses and we immediately spiral into a depression. That’s the first option--not a good one.

The Japan model: endless stagnation: Japan’s crisis started 22 years ago. They have had massive budget deficits every year since then. They have taken government debt from 60 percent of GDP to 240 percent of GDP. In that way, they have prevented a great depression. But this is going to have a bad ending sooner or later. That’s the model the US is on for now. Massive government spending until we go broke. The US can probably do that for another ten years before we get to the end of that road.

Bold borrowing and investment aimed at growth: Duncan believes that we need to learn from Japan's experience. if the Japanese have understood 22 years ago their crisis was going to go on for so long and that they would spend so much, they wouldn't have wasted all this government building bridges to nowhere and paving the Japanese country side with cement. Instead they would have invested in 21st Century cutting-edge technologies. if they had done that on an aggressive enough scale, they would now be a global economic superpower. The United States needs to learn that. One way or another, the US is going to spend trillions of dollars supporting the economy. Will we waste this on too much consumption and war? Or are we going to invest it and grow our way out?

What Duncan would like to see over the next ten years is for the US government to invest a trillion dollars in solar energy, a trillion dollars in genetic energy, a trillion dollars bio- and nano- technology. He is not talking about deleveraging at all. He wants major stimulus.

Duncan believes that an abrupt deleveraging will cause our civilization to collapse. That's not a realistic option. The only real option is for us to invest and grow our way out. In other words, the US has global military dominance. because the US government invests more in our military than the rest of the world combined. Duncan believes that it’s time to apply this very successful government investment strategy to American industry and power generation.

Duncan is not necessarily hooked on solar energy. He concedes he’s not a scientist and maybe fusion is the way to go. He’s not just talking about investing in a few solar companies. What he has in mind is carpeting the Nevada desert with hundreds of thousands of american made solar panels and building a grid coast to coast to transmit the energy on. And transitioning the automobile industry from being gasoline burning to being electric burning. And developing batteries that make cars go 70 miles per hour for a very long time. These are big problems, but he believes that if we throw enough money at them, we can solve them, as we have done before.

For instance, he says: think about the Manhattan project. the US government took all the geniuses it could find, put them together in New Mexico, threw limitless amounts of money at them and they came up with a weapon that won the war in Asia.

A different kind of economy

Duncan here is making an argument that could be linked to what Joe Stiglitz has advocated, namely, that we are undergoing a phase change to a new kind of economy. Stiglitz calls it a service economy. Richard Duncan calls it an economy less dependent on credit. Richard Florida calls it the Creative Economy. Whatever we call it, getting to it will require a very different kind of management and, as Stiglitz says, "a massive investment program—as we did, virtually by accident, decades ago in the Second World War—that will increase our productivity for years to come, and will also increase employment now.” We will need large investments in infrastructure, technology, and education for decades.